India’s Supreme Court recent ruling in Commissioner of Income Tax v. M/S. Whirlpool of India Ltd. has underscored the need for guidance in the transfer pricing treatment of certain expenses of Indian enterprises.
The treatment of advertising, marketing, and promotion expenses incurred by an Indian associate enterprise of a multinational enterprise has been a vexing issue under the Indian transfer pricing regulations. Such AMP expenses can include advertisements, sales promotions, sponsorships, and trade promotions.
Judgments by the tax tribunal, the Delhi High Court, and the Supreme Court have now collectively provided valuable guidance for taxpayers and revenue authorities in addressing disputes over AMP expenses. The rulings aim to ensure equitable tax administration and mitigate unwarranted litigation by emphasizing procedural rigor and evidentiary standards.
The issue stems from the tax authorities’ claim that excess AMP expenses incurred by an Indian associated enterprise lead to the creation of “marketing intangibles”—such as brand identity and image for the foreign associated enterprise—and amount to a service being performed by the Indian associated enterprise for its foreign parent.
The Indian-associated enterprise should then be compensated for this on an arm’s-length basis, given that such expenses come under the ambit of “international transactions” subject to transfer pricing. However, Indian-associated enterprises may often argue that such costs are incurred wholly to build the business in India and shouldn’t be subject to transfer pricing.
Given that the treatment of AMP expenses hasn’t been expressly dealt with under the Indian transfer pricing regulations, the taxability of such expenses has often been a subject of debate, with different judicial forums giving conflicting decisions.
In LG Electronics India, the income tax tribunal held that excessive AMP expenses incurred by the Indian associated enterprise were an international transaction subject to transfer pricing, without there being an express agreement to that effect between the parties.
The tribunal assumed an implied understanding between the parties and applied the “bright line test” comparing the AMP expenses incurred by the Indian associated enterprise with that of comparable companies, for concluding that the excess AMP expenses were subject to transfer pricing.
However, the Delhi High Court in Sony Ericsson Mobile Communications observed that while AMP expenses could be considered as an international transaction, application of the bright line test for computing the arm’s-length price was invalid as it didn’t have any statutory backing.
Whirlpool Case
The ruling of the Indian Supreme Court in Whirlpool has now underscored some critical principles in this area in transfer pricing and tax law:
- The need for concrete evidence to establish international transactions.
- The importance of adhering to statutory methods for determining the arm’s-length price.
- The principle of non-duplication in disallowances under the transfer pricing regulations and general deductibility provisions.
Whirlpool of India Ltd., the Indian associated enterprise of Whirlpool Corp. US, produced and distributed appliances in India. Whirlpool of India incurred advertisement expenses and sought to exclude a specific sum, described as pricing adjustment, from the AMP expenses to determine the arm’s-length price.
Whirlpool Corp. argued that this “pricing adjustment” represented leverage in the maximum retail price of its products sold to dealers and distributors, functioning as a profit markup and an extra trade discount. But on assessment, the tax authority rejected Whirlpool’s claim to exclude this amount from the total AMP expenses, asserting that it was a strategy used by Whirlpool to foster brand loyalty among its dealers.
Consequently, the tax authority included the pricing adjustment in the total AMP expenses for benchmarking purposes, holding that such expenditure wasn’t incurred “wholly and exclusively” for Whirlpool of India’s business, as it still contributed to brand building for the parent company.
On appeal, the tax tribunal relied on the ruling in LG Electronics India to exclude the pricing adjustment from AMP expenses and hold that discounts and incentives offered to dealers don’t fall under AMP expenses as they don’t contribute to brand promotion.
It also noted that discounts and similar adjustments are beyond the scope of AMP expenses to determine the arm’s-length price.
The tribunal also clarified that deductible business expenses should be allowed in their entirety even if they incidentally benefit a third party, such as the foreign associated enterprise.
However, transfer pricing provisions in international transactions override the general deductibility provisions for business expenses; they require segregation of expenses benefiting the foreign associated enterprise from those benefiting the Indian business. The matter was remitted to the assessing officer/transfer pricing officer for a revised computation; the tax authority appealed to the Delhi High Court.
In outlining essential steps for transfer pricing adjustments under the Indian income tax law, the Delhi High Court emphasized that transfer pricing adjustments can’t be speculative and must be based on concrete evidence of an international transaction involving AMP expenses.
The tax authority’s approach to treating AMP expenses as a separate transaction needed to be revised because it lacked sufficient documentation or agreement demonstrating that the expenses were incurred on the order of the foreign associated enterprise. The court also found that the tax authority had been unable to demonstrate by some tangible evidence that there was an international transaction involving AMP expenses between the Indian subsidiary and its foreign parent.
The High Court further agreed with the tribunal’s reliance on LG Electronics India, stating that AMP expenses benefiting the foreign associated enterprise must be segregated from those incurred for the Indian entity’s business. However, it cautioned that the transfer pricing officer’s simplistic method of determining the arm’s-length price as a percentage of sales lacked an empirical basis and violated transfer pricing principles.
The High Court upheld the tribunal’s decision to remit the matter for a detailed analysis of AMP expenses. The tax authority appealed this decision to the Supreme Court of India via a special leave petition.
In affirming the High Court’s direction to re-examine AMP expenses through a proper transfer pricing analysis, the Supreme Court stressed the need to adhere to statutory provisions and judicial precedents to ensure fairness in transfer pricing assessments.
The issue hasn’t however been fully resolved because multiple special leave petitions remain pending before the Supreme Court against conflicting rulings on treating AMP expenses.
The case is Commissioner of Income Tax (LTU) v M/S Whirlpool of India Ltd., Supreme Court of India, Nov. 20, 2024
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
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Aditya Singh Chandel is partner and Suhail Bansal is a senior associate at AZB & Partners, New Delhi. The views expressed in this article are those of the authors and do not necessarily reflect the views of the organization with which the authors are affiliated.
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